The SEC’s Office of Compliance Inspections and Examinations issued a risk alert, announcing a series of examination initiatives focused on mutual funds and exchange-traded funds, specific business practices and regulatory compliance areas. A client alert by law firm Drinker Biddle discusses OCIE’s risk alert and the exam initiative in depth. The staff will generally assess:
- policies and procedures of funds and/or their advisers, to validate that they are designed to address risks and conflicts, including funds’ boards oversight of the compliance program;
- disclosures by funds to investors in their prospectuses and other filings and shareholder communications, and by advisers to the funds’ boards, regarding risks and conflicts; and
- deliberative processes utilized by funds, their advisers, and their boards exercising oversight, particularly when assessing practices and controls related to risks and conflicts, including disclosures, portfolio management compliance, and fund governance
The risk alert also listed board-specific compliance risks, conflicts, and practices the staff will assess during its broader review of certain categories of advisers. The list below is not exhaustive and the staff cautions it may select additional examination topics during its examinations.
- With respect toindex funds that track custom-built indexes, the staff will review the effectiveness of the funds’ compliance programs for portfolio management and their boards’ oversight of such programs.
- For smaller, or thinly traded ETFs, the staff will review whether board oversight incorporates the ETF’s ability to continue as an ongoing concern.
- For funds with aberrational underperformance relative to their peer group, the staff’s review will include the effectiveness of the funds’ compliance programs and whether boards are exercising appropriate oversight of their compliance programs.
- For mutual funds with higher allocations to certain securitized assets, the staff will focus on the policies and procedures addressing portfolio management activities, investment risks, and liquidity, among other things. The staff will also scrutinize valuation and pricing policies and procedures; the funds’ pricing practices and use of vendors, especially with respect to illiquid securities and other securities or asset classes that are potentially difficult to value; governance and board oversight practices, particularly those regarding pricing/valuation; and disclosures to investors.
- For advisers that manage both mutual funds and private funds, the staff will look into controls for ensuring appropriate brokerage, best execution, and trade allocation practices, including trade aggregation and allocation of investment opportunities in a manner consistent with the advisers’ fiduciary duty; allocation practices for various fees and expenses; and disclosures to investors and funds’ boards.
- For funds managed by advisers that are relatively new to managing mutual funds, the staff will evaluate fund governance to ensure that boards are provided with sufficient information to perform their duties; the effectiveness of advisers’ and funds’ compliance programs; and marketing and distribution efforts related to the funds.